E-piphany

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments (updated site coming soon).

• CPI Day! I have to be honest – with the markets closed and this number likely to not have a lot of meaning, I almost skipped doing this this morning. But, thanks to M2, lots more people are suddenly listening so…obviously CPI is starting to be important. So let’s try.
• The consensus for today, to the extent “consensus” means anything, is for -0.3% headline and +0.1% on core. But these are even more guesses than usual.
• The BLS stopped taking prices a couple of weeks ago. That will have less effect than if that had happened a few years ago, b/c they ‘survey’ some prices using database downloads from retailers e.g. apparel.
• But it still means that we don’t know what they’ll do about missing prices. Normally the BLS imputes an estimated figure for an item based on similar items…but if whole groups of items or categories are missing, less clear. Do they assume zero? Prior trend?
• I actually think that this number won’t have too many of those problems but there will be some and next month will be very odd – and some chance they don’t publish at all because they can’t get statistically significant data.
• In the meantime…remember we are coming off of recent strong data. Core was 2.37% y/y last month, and in general has headed higher. Before this, I was expecting 2.5% core by summer. Now that will take longer! (You can imply the word “maybe” before every statement this month.)
• Lodging Away from Home is one place we’ll surely see an effect this month, and airfares, but beyond that who knows. And we are dropping off a weak +0.16% from last March so the core y/y figure might even stay steady. Or it could drop 0.3%. Who knows.
• What we DO know is headline inflation is going to fall and in a month or 2 will show negative changes, which will prompt “DEFLATION!” screams. But headline just follows gasoline. That’s important – it’s also the reason people think infl is related to growth. Only headline.

• I doubt we’ll get very close to core deflation in this cycle. See my recent article Last Time Was Different for why I don’t think we’ll see similar effects. But mkts are priced for long-term disinflation and deflation.
• Oh and of course yesterday’s M2 chart. Probably discuss that more later today. Anyway, I’d say good luck but with markets closed you can’t do anything anyway! So just “hang on” and we’ll try and figure this out over the next few months.

• I will be back in 5 minutes with thoughts on the figures and diving as deep as I can this month.
• Core -0.1% m/m, down to 2.1% y/y. That’s a bigger fall than expected, but with these error bars I wouldn’t be shocked. Normally missing by 0.2% on core is a big deal. More interesting is that they got headline right to within 0.1%! It ‘only’ fell -0.4% m/m in March.
• Here are the last 12 core CPI prints. This chart is gonna look kinda wacky for a while.

• Broadly, core goods were -0.2% y/y, a decline from flat. More amazing is core services, dropping to 2.8% y/y from 3.1%.
• Haha, that core services number is EVEN MORE AMAZING than you think. Because it didn’t happen from Owners Equivalent Rent (+0.26% m/m, 3.22% y/y) or Primary Rents (+0.30% m/m, 3.67% y/y). Both slower y/y but basically same m/m from Feb.
• So if rents didn’t decelerate, where do we get the big drop in core services? Lodging Away From Home was -6.79% m/m, dropping to -6.38% y/y from +0.78% last month. I should drop the second decimal.
• BTW, good time to remember that VOLUMES of transactions don’t enter into CPI monthly. This is just a survey of prices. So if no one bought any apparel, but we have a price, that’s what gets recorded. Lodging fell because prices actually were down hard, as you probably know.
• CPI for Used Cars and Trucks was +0.82% m/m. Some people were worried about autos but I’m not sure they should be. Big supply shock in cars because of parts supply chain. If I were a dealer I wouldn’t be marking down my existing inventory.

• Airfares -12.6% m/m. That’s worth about 0.1% on core all by itself. So we expected big declines in airfares and Lodging Away from Home (worth about 0.06%), and got them. Core ex- those two items still had some softness, but not horrendous.
• Core ex-housing declined from 1.70% y/y to 1.45% y/y. Again, a lot of that were those two items I just mentioned. But 1.45% core ex-housing is still higher than it was last July.
• Now, in medical care I’m not sure how to think about any of this. Medicinal Drugs were -0.04% m/m, after -0.43% last month, pushing y/y to 1.31% from 1.85%. But lots of drugs are really hard to get right now and of course we now know most of our APIs come from China.
• That may be a case of some shortages, because in the short term no one wants to be seen jacking up the price of drugs. Prescription drugs decelerated y/y; non-prescription accelerated.
• Physicians’ Services +0.34% m/m vs +0.21% prior month. Hospital Services +0.40% vs -0.12%. How in the heck do you measure this when most of those doctors and services are doing one thing? And a very crucial one indeed. What’s the price of a hip replacement right now?
• OK, biggest m/m changes down, other than fuel. Public Transportation -65% (annualized), car/truck rental -58%, Lodging Away from Home -57%, Infants/toddlers apparel -41%, womens/girls apparel -30%, footwear -29%.
• Which makes me realize I forgot to mention Apparel was -2% m/m. That’s another 5bps off the core inflation rate.
• There were still some increases on the month. Biggest ones other than food were Tobacco and Smoking Products (12.5% annualized), nonalcoholic beverages (+12%), and Used Cars and Trucks (+10%).
• FWIW, the early look to me is that MEDIAN CPI will still be around 0.22% or so. That’s what long-tail negatives do to core! So while y/y Core dropped sharply, y/y median will still be around 2.8%.
• So, coarse but…core -0.1% m/m. Add back 0.06% lodging, 0.10% airfares, 0.07% apparel and 0.07% for public transportation (cuffing it) and you get back to +0.2%. Which means that outside of those categories there wasn’t much disinflation pulse. Median will say same thing.
• That probably more means that prices haven’t really reacted yet that that there will be zero impact of COVID-19. But I don’t think we’ll see a big impact lower on prices. At least not lasting very long.
• Haven’t done many charts yet. But here’s one I haven’t run in a while. Distribution of y/y price changes by low-level item categories in the CPI. Look at that really long tail to the left. Take off just the last bar on the left and you get 2.37% core roughly.

• Here’s the weight of categories over 2% y/y change, over time. Just another way of saying that we haven’t seen any big effects yet. Unknown is just how much the trouble in collecting affects this.

• Pretty good summary and gives me more confidence in the data – they’re at least calling people! But interestingly, not so much doctors/hospitals. So asterisk by Medical Care.
• BLS has posted this, explaining how they’re collecting prices. https://bls.gov/bls/effects-of-covid-19-pandemic-on-bls-price-indexes.htm#CPI
• So let’s do the four-pieces charts and then wrap up. For those new to my monthly CPI tweets, these four pieces add up to CPI, each is 20%-33%, but each behaves differently from a modeler’s perspective.
• First piece: Food and Energy. This will go much lower. As I said up top, we will be in deflation of the headline number pretty soon. But, I think, only the headline number.

• Core goods. This declined a tiny bit, mostly apparel. I think the short-term effect here is indeterminate but might actually be higher as some goods made overseas get harder to get (ibuprofen??)

• Here’s where the rubber meets the road. Core Services less Rent of Shelter. Was in a good trend higher and about to be worrisome. Dropped a bit, but with an asterisk on medical care.

• Rent of Shelter – this looks alarming! And rents declining is the ONLY way you can get core deflation. But…Rent of Shelter includes lodging away from home. That’s the dip, is in that 1% of CPI. The 31% that is primary and OER, not so much.

• That last chart calls for one more on housing. Here is OER, the biggest single piece of CPI. It’s right on model. As yet, no sign of any big effect from COVID-19 either now, or in the forecast that’s driven by housing market data.

• End with 1 final chart. We started w/ M2 chart showing the biggest y/y rise in history. The counterpoint is “what if velocity falls.” But vel is already @ record low. To drop, you need lower int rates (from 0?), or huge long-lasting cash-hoarding.Hard to see.

• Thanks for tuning in. I’ll collate these in a single post in the next hour or so.

So what was most amazing about today’s data? I suppose it was that, outside of the things we knew would be disasters (airfares, hotels) the effects of the virus crisis were very small. And you know, that sort of makes sense. If I’m a producer of garden rakes (I honestly just pulled that out of the air), why would I change my prices? I’m not seeing traffic, but it isn’t because my prices are too high. From a seller’s perspective, it only makes sense to lower price if lower prices will induce more business. Lowering the price of rakes isn’t going to sell more rakes. It isn’t that people have no money to buy rakes – with the government fully replacing wages of laid off workers, and covering the wage costs for small businesses so they don’t need to lay anyone off, and sending everyone a fat check besides, there’s no shortage of people with money to spend. (I know we read a lot about the tragedy of the millions being laid off, but it’s not much of a tragedy yet since they’re being paid the same as before!)

[As an aside, businesses with high fixed overhead and low variable costs – hotels are a classic example; it costs very little for the second occupied guest room – might lower prices significantly since if they can cover their variable costs then anything above that goes to covering fixed overhead. That’s what airlines did initially too, but when they realized after that knee-jerk response that they couldn’t fill the planes even if they offered free flights, they started canceling enormous numbers of flights. I’ve actually seen some of the fares that I track rise in the last week or two as the number of flights out of NYC has dwindled to very few! But it’s harder to mothball a hotel than to mothball a plane.]

The NY Fed published a really insightful article today entitled “The Coronavirus Shock Looks More like a Natural Disaster than a Cyclical Downturn.” Although they focused on the path of unemployment claims, a similar analysis can take us to the inflation question. In a natural disaster, we don’t see deflation. If anything, we tend to see inflation as some goods get harder to acquire. The amount of money available doesn’t decline, assuming the government deploys an emergency response that includes covering non-insured losses, and the amount of goods available drops. In today’s circumstance, we have more money available – as the M2 chart shows – than we did before the crisis, and if anything we will have fewer things to buy when it’s all over as supply chains will remain disrupted for a long time and a lot of production will surely be re-onshored. But you don’t need the latter point to get disturbing inflation. All you need is for the money being created to get into circulation rather than reserves (which is what is happening, which is why M2 is soaring), and for precautionary money-hoarding to be a short-term phenomenon. I believe the money will be around long after the fear has died away, because for the Fed to drain a few trillion by selling massive quantities of bonds is much, much more difficult than to add a few trillion by buying bonds that the Treasury coincidentally needs to sell more of right now.

The quality of the CPI numbers will be sketchy for a while, but I am fairly impressed that this release wasn’t as messy as I was prepared for. The inflationary outcome may well be messy, though! With 14% money growth, and little reason to expect a lasting velocity decline, it’s hard to get an innocuous inflation outcome. But markets are still offering you inflation hedges at prices that imply you win even if inflation drops a fair amount from the current level. If you don’t have those hedges, you’re making a very big bet on deflation.

Happy Easter.